T.C. Memo. 2004-286
UNITED STATES TAX COURT
ESTATE OF HOWARD GILMAN, DECEASED,
BERNARD D. BERGREEN AND NATALIE MOODY, EXECUTORS, Petitioner
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10748-02. Filed December 28, 2004.
Thomas H. Moreland, Jeffrey S. Boxer, Jerome J. Caulfield,
and Richard B. Covey, for petitioner.
Milan K. Patel, Frank J. Jackson, and Gerard Mackey, for
respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COLVIN, Judge: Respondent determined a $30,475,381.13
deficiency in the Federal estate tax of the Estate of Howard
Gilman (the estate).
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When Howard Gilman (decedent) died in 1998, his estate
consisted primarily of stock of Gilman Investment Co., Inc.
(GIC), a holding company for decedent’s businesses and other
assets (the Gilman assets). Before he died, decedent formed the
Howard Gilman Foundation (the foundation). Decedent bequeathed
the residue of his estate to the foundation.
Bernard D. Bergreen (Bergreen) and Natalie Moody (Moody)
were coexecutors of the estate, the managers of a limited
liability company named HG Estate, LLC (HG), officers of GIC, and
members of the board of directors of the foundation.
Bergreen and Moody hired William Davis (Davis) to serve as chief
operating officer of Gilman Paper Co. and Gilman Building
Products, effective June 1998.
In 1999, as part of a tax-free reorganization under section
368,1 the executors transferred the GIC stock and all of GIC’s
assets to HG and its subsidiaries. The foundation was the only
member of HG. Bergreen received tax advice that, if the
restructuring were completed by January 28, 1999, and the assets
then sold, HG would save $160 million in tax on capital gains
which would been have resulted if the estate had sold the assets.
1
Section references are to the Internal Revenue Code in
effect as of the date of decedent’s death. Rule references are
to the Tax Court Rules of Practice and Procedure. Amounts have
been rounded to the nearest dollar.
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The estate received $143 million in promissory notes from
some of HG’s businesses when the assets were transferred to HG.
The notes were scheduled to pay interest from 1999 to 2004, and
to be fully repaid in January 2004.
The financial condition of HG’s businesses declined in 2001.
In October 2002, which was 15 months before the estate was
scheduled to receive repayment of the $143 million in notes, the
estate borrowed about $38 million (the Farm Credit loan),
repayable over 10 years. The estate agreed to pay almost $16
million in closing costs and interest, which it seeks to deduct
as an administration expense under section 2053. The estate also
seeks to deduct administration expenses which it paid from the
estate’s income.
After concessions, the issues for decision are:
1. Whether (or to what extent) the estate may deduct as
administration expenses under section 2053(a)(2) interest and
closing costs for the $38 million Farm Credit loan. We hold that
it may to the extent described herein.
2. Whether, in addition to the $1 million respondent
conceded, the estate may deduct $3,507,723 as additional
administration expenses (additional expenses) which it paid from
income of the estate. We hold that the estate may deduct
additional administration expenses of $1,803,939.
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
A. Decedent and the Executors of Decedent’s Estate
Decedent resided in New York, New York, when he died on
January 3, 1998. Bergreen and Moody, the executors of decedent’s
estate, lived in New York, New York, when the petition was filed.
Bergreen is an attorney and was decedent’s close business
adviser. Bergreen is an officer and director of decedent’s
corporations. Moody was decedent’s administrative assistant and
vice president and secretary of decedent’s corporations.
In 1981, decedent formed the foundation to support the
performing arts, wildlife conservation, and cardiovascular
disease research. The foundation is tax exempt under section
501(c)(3). Bergreen was a director of the foundation. Moody
became a director of the foundation in 2000.
Decedent owned all of the outstanding stock of Gilman
Investment Co. (GIC), some apartments, and $702,890 in cash or
cash equivalents when he died. The fair market value of
decedent’s estate was more than $611 million when he died.
B. The Gilman Businesses and the Hiring of Davis
Decedent was chairman of the board of directors of GIC when
he died. GIC owned about 50 businesses, including Gilman
Building Products, Gilman Paper Co., Gilman Timberlands, and
Gilman Financial Services. GIC’s holdings included timberland,
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sawmills, a railroad, rail cars, and a financial services
company. Gilman Building Products produced lumber.
Gilman Building Products had net positive cashflows which
averaged more than $42 million per year in 1994-99. The GIC
businesses, including Gilman Paper Co., Gilman Timberlands, and
Gilman Financial Services had net negative cashflows of at least
$40 million in 1998. GIC used the net positive cashflow of
Gilman Building Products to pay operating expenses of the GIC
businesses.
GIC also owned the White Oak Plantation (White Oak), an
8,000-acre estate that has a conference center and a wildlife
conservation center with a scientific breeding program for
endangered animals and birds. White Oak houses decedent’s
collection of about 6,000 photographs, which, according to one
appraisal obtained by Bergreen, was worth $80 million in 1998.
Gilman Building Products used about one-third to one-half of its
annual net positive cashflow to maintain White Oak and to fund
the operations and grants of the foundation.
Davis was the chief operating officer of Gilman Paper Co.
and Gilman Building Products until he retired in February 1996.
His successor died of cancer in June 1998. Early in 1998, while
Bergreen and Moody were officers of GIC and coexecutors of
decedent’s estate, Bergreen, Moody, and Davis agreed that Davis
would be paid $5 million to resume his duties as chief operating
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officer of Gilman Paper Co. and Gilman Building Products in June
1998. Bergreen and Moody wanted Davis to help revive the Gilman
businesses. Davis was paid $1.5 million in 1998, $1.2 million in
1999, and $1.2 million in 2000.
C. Decedent’s Will
Article 10 of decedent’s will provides that his executors
were not to receive executor’s fees or commissions, but that they
would continue to receive compensation from Gilman Paper Co. or
Gilman Investment Co. (GIC) as they had when decedent was alive.
Decedent directed that Gilman Paper Co. be sold. Article 12 of
decedent’s will provides:
if the * * * [Gilman Paper Co.] is sold by my executors
while Bernard D. Bergreen is acting as an executor,
Bernard D. Bergreen, P.C. shall be entitled to
compensation for services rendered in connection with
such sale * * *.
Article 13 of decedent’s will provides that the executors
may decide whether receipts were income or principal and whether
expenses were paid from income or principal. Article 8 provides
that the foundation was to receive the residue of the estate
after payment of estate taxes and administration expenses.
D. Administration of Decedent’s Estate in 1998-99
1. Loans, Payment of Expenses, Bequests, and Estate Taxes
The executors paid estate administration expenses including
more than $150,000 for funeral expenses and perpetual care and
more than $4 million in legal fees. The executors also paid 26
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cash bequests totaling $30,565,000 in May 1998. GIC borrowed
$30,565,000, which the estate borrowed from GIC to pay the cash
bequests. GIC and the estate were illiquid at that time.
Several months after decedent died in 1998, Bergreen
arranged for a $90 million line of credit so GIC could
consolidate loans to help sell the GIC businesses. GIC and the
estate were still illiquid in October 1998. On October 3, 1998,
GIC borrowed $6 million, which it gave to the estate to pay some
of its Federal and State estate taxes.
2. Transfer of GIC Stock, Assets, and Liabilities to HG
and HG Subsidiaries
Late in 1998, Bergreen received tax advice that, by
transferring stock, assets, liabilities, and businesses of GIC
and its subsidiaries from the estate to a newly organized limited
liability company and its subsidiaries through a series of
mergers tax free under section 368 (the restructuring), the
estate could save $160 million in capital gains tax that would
result if the estate sold GIC’s assets and businesses. To
accomplish those tax savings, (1) the restructuring had to be
completed before January 28, 1999, see sec. 1.337(d)-4(e), Income
Tax Regs.; and (2) Gilman Building Products could not be sold for
5 years because of the continuity of business requirement, see
sec. 1.368-1(d), Income Tax Regs.
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The executors and the foundation decided to implement the
restructuring plan. HG was organized on January 13, 1999. The
foundation became its only member.
The restructuring was completed on January 14, 1999. As a
result of the restructuring: (a) The Gilman businesses, except
for 77,000 acres of timberland already under contract of sale,2
were transferred from GIC to HG; (b) GIC, the sole member of HG,
merged into the foundation, making the foundation the sole member
and sole owner of HG; (c) Bergreen and Moody were the sole
managers of HG, which gave them exclusive control over HG’s
assets and their subsequent sale; and (d) HG and its subsidiaries
had legal title to all the assets previously held by GIC and its
subsidiaries other than 77,000 acres of timberland held by the
foundation.3
HG obtained a $250 million line of credit from NationsBank
to refinance and consolidate debt and to provide working capital
for the Gilman businesses. After the restructuring, HG and its
subsidiaries began to sell the GIC assets and businesses except
for Gilman Building Products.
2
Before the restructuring, GIC transferred title to 77,000
acres of timberland to the foundation.
3
The foundation sold the 77,000 acres of timberland in Jan.
1999.
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3. The Notes
As part of the restructuring, the estate received $143
million in notes (subordinated to the $250 million line of
credit) from subsidiaries of Gilman Building Products and from
Gilman Paper Co.’s railroad. All of the notes were due to be
paid in full on January 31, 2004.4
Interest but not principal was payable annually beginning
January 31, 2000. However, on January 28, 2000, the executors
and obligors of the $143 million in notes agreed that interest on
the notes could be deferred at the option of the obligors. The
total amount of interest to be paid by 2004 was about $46.5
million. The executors expected to use the interest and
principal payments on the notes to pay estate expenses including
Federal and New York State estate taxes.
After the restructuring, the estate held $183 million in
assets, including the notes in the amount of $143 million, and
apartments and cash.
4. Election To Defer Tax Payments
On April 1, 1999, the executors elected under section 6166
to pay Federal estate tax in 10 annual installments, beginning on
4
As part of the sale of Gilman Paper Co. in Dec. 1999, a
debt of $5 million (part of the $143 million in notes) was
cancelled.
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October 3, 2003.5 The executors also elected under New York Tax
Law section 997 (McKinney 1999) to pay New York estate tax in 10
annual installments.
E. HG and Foundation Finances
1. HG’s Cash Requirements in 2000-02
Beginning in 2000, there was a reduction in the net positive
cashflow of Gilman Building Products. Gilman Building Products’
net positive cashflow decreased from an average of more than $42
million per year in 1994-99 to $3.5 million in 2000, $19 million
in 2001, and $9.2 million in 2002.
By the end of 2001, HG needed $30 to $40 million in cash and
cash equivalents as working capital to pay operating expenses of
its businesses. At that time, HG had cash and cash equivalents
of $36.3 million. On October 18, 2002, HG had cash and cash
equivalents of $16.7 million.
HG received more than $287 million from the sale of Gilman
assets and businesses from 1999 to 2002. HG used most of those
receipts to repay the $250 million line of credit from
NationsBank. HG used the remainder as working capital and to pay
other expenses.
5
The estate paid four installments of interest only,
beginning Oct. 3, 1999.
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2. The Foundation’s Compensation Committee
In 2001, the foundation’s compensation committee, which was
formed at the request of the attorney general of New York
pursuant to the attorney general’s supervisory authority over
charitable foundations in the State of New York,6 hired a
compensation consultant, Pearl Meyer & Co. (Pearl Meyer), to
evaluate reasonable compensation for Bergreen, Moody, and Davis
and six other executives of the foundation and its subsidiaries.
In October 2001, the compensation committee reviewed Pearl
Meyer’s report and recommended that the foundation pay Bergreen
$17 million as compensation for services he provided to HG under
article 10 and for selling Gilman Paper Co. under article 12.
Bergreen and Moody requested, and the compensation committee
recommended, that Davis receive $5 million for his return from
retirement and the successful turnaround and sale of Gilman Paper
Co. The foundation’s board of directors approved the committee’s
recommendation.
F. Administration of the Estate in 2000-03
1. Allocation of $1 Million in Expenses to Income
On November 6, 2001, the executors reported to respondent
that they had agreed to pay legal fees totaling $3.6 million,
6
See N.Y. Est. Powers & Trusts Law sec. 8-1.4 (McKinney
2003) (attorney general has enforcement and supervisory powers
over nonprofit entities); In re Estate of Shubert, 442 N.Y.S.2d
703, 712-713 (N.Y. Sur. 1981).
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$3,038,000 of which had been paid. The executors elected to pay
$1 million of these expenses from income by executing Form 4421,
Declaration--Executor's Commissions and Attorney’s Fees.
2. The Executors’ Decision To Pay the Estate Tax in Full
During the examination of this case, which began in 2001,
the Internal Revenue Service (IRS) examiner told the tax counsel
for the estate that, because the estate had transferred assets to
HG, the estate’s ability to continue to defer estate tax under
section 6166 was doubtful, and acceleration of payment of all
estate tax under section 6166(g) would likely result.
In January and February 2002, the executors obtained written
opinions from tax attorneys recommending that the estate pay its
estate tax in full to avoid the risks of acceleration under
section 6166(g). The executors decided to follow that advice.
3. Farm Credit Loan
The executors estimated that the estate needed $38 million
to pay: (a) $9,797,400 for Federal estate tax and interest; (b)
$2,915,900 for New York State estate tax and interest; (c)
$19,470,525 for compensation for Bergreen; (d) $5 million for
compensation for Davis; and (5) $816,175 for other miscellaneous
administration expenses.
On October 18, 2002, Bergreen and Moody, acting as
executors, borrowed $38 million from Farm Credit Bank of North
Florida, CA (Farm Credit loan). The loan was secured by a
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mortgage on White Oak and guaranteed by HG. HG pledged
collateral for the Farm Credit loan. The Farm Credit loan is
payable over 10 years with a fixed schedule for payment of
principal and interest. The total amount of interest to be paid
on the Farm Credit loan is $15,734,293. Closing costs for the
Farm Credit loan were $200,000.
On November 1, 2002, the estate used proceeds from the Farm
Credit loan to pay $9,610,302.91 in Federal estate tax and
$2,805,802.13 in New York estate tax. The estate retained the
rest of the proceeds from the Farm Credit loan to pay
compensation to Bergreen and Davis and certain administration
expenses.
As of February 1, 2004 (the day after the due date for
repayment of the $143 million in notes), the estate was scheduled
to have paid interest on the Farm Credit loan totaling $2,665,850
and principal in the amount of $742,448.47, leaving a principal
balance of $37,257,551.53.
4. Income Tax Returns and Administration Activities in
2003
From March 1999 to January 2003, the estate received
$23,617,031 cash from HG as interest payments on the $143 million
in notes.7 On July 1, 2002, HG gave the estate a $22.9 million
note for unpaid, accrued interest due through January 31, 2002.
7
The estate received $4,705,631 from HG in 2003.
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However, the estate reported total income of only $2,844,738 for
1998-2002 on its Forms 1041, U.S. Income Tax Return for Estates
and Trusts, for tax years 1998-2002.
On May 1, 2003, the estate prepared a draft fiduciary
accounting which states that the estate paid $37 million from
principal to administer the estate. As of October 8, 2003, the
executors had paid legal expenses to three law firms and
consulting fees to two firms totaling $4,507,723.
On November 24, 2003, the executors changed the amount of
administration expenses allocated to estate income from $1
million to $4,507,723.
G. Surrogate’s Court Proceeding With Respect to Amount of
Compensation Due to Bergreen
Bergreen and Moody as executors filed a petition on a date
not specified in the record in the Surrogate’s Court of the
County of New York seeking approval of the amount of Bergreen’s
compensation. The Surrogate’s Court supervised negotiations in
May 2003 between the State attorney general’s office, Bergreen,
and the independent directors of the foundation, in which the
parties agreed that Bergreen would be paid $12.5 million.
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OPINION
A. Whether the Estate May Deduct Interest and Closing Costs
Paid on the Farm Credit Loan
1. Contentions of the Parties and Background
The estate contends that all of the Farm Credit loan
proceeds were borrowed for the purpose of paying estate taxes and
deductible administration expenses of the estate including (a)
Bergreen’s compensation of $19,470,525;8 (b) Davis’s compensation
of $5 million; and (c) miscellaneous administration expenses of
$816,175.
Respondent contends that none of the interest paid on the
Farm Credit loan is deductible under section 2053. Respondent
contends that the loan was unnecessary because the estate had
enough liquid assets when it borrowed about $38 million from Farm
Credit to pay its taxes and administration expenses. Respondent
alternatively contends that, if the estate was illiquid when it
obtained the Farm Credit loan, the loan was unnecessary because:
(a) Some of the estate’s planned uses of the loan proceeds (e.g.,
compensation for Bergreen and Davis) are expenses of HG and are
not administration expenses of the estate; (b) the estate has not
substantiated miscellaneous administration expenses of $816,175;
(c) the executors caused the estate’s illiquidity by distributing
8
The estate concedes that $2.4 million to be paid to
Bergreen as compensation for 1996 and 1997 is not an
administration expense.
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the estate’s principal assets to the foundation in the
restructuring; (d) the estate should have retained enough assets
to sell to pay its expenses; (e) the executors had elected to pay
the estate tax in 10 annual installments; and (f) the executors
could have demanded that the foundation return some of the
proceeds from HG’s sale of assets transferred from the estate.
The estate disputes respondent’s contentions.
An estate may deduct administration expenses allowable under
the probate law of the jurisdiction where the estate is being
administered, sec. 2053(a)(2), and which are actually and
necessarily incurred in administering a decedent’s estate, Estate
of Grant v. Commissioner, 294 F.3d 352, 353 (2d Cir. 2002), affg.
T.C. Memo. 1999-396; sec. 20.2053-3(a), Estate Tax Regs.9
Interest on funds borrowed to pay taxes or other debts of
the estate while the estate is illiquid (i.e., while the estate
9
Sec. 20.2053-3(a), Estate Tax Regs., provides in part:
The amounts deductible from a decedent’s gross
estate as “administration expenses” * * * are limited
to such expenses as are actually and necessarily
incurred in the administration of the decedent's
estate; that is, in the collection of assets, payment
of debts, and distribution of property to the persons
entitled to it. The expenses contemplated in the law
are such only as attend the settlement of an estate and
the transfer of the property of the estate to
individual beneficiaries or to a trustee * * *.
Expenditures not essential to the proper settlement of
the estate, but incurred for the individual benefit of
the heirs, legatees, or devisees, may not be taken as
deductions.
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can obtain funds to pay those expenses only through sale of
estate assets at a price below the normal market price) may be
deductible as an administration expense under section 2053(a)(2).
Estate of Todd v. Commissioner, 57 T.C. 288 (1971) (9-month
loan); Estate of Thompson v. Commissioner, T.C. Memo. 1998-325
(series of five 1-year notes); McKee v. Commissioner, T.C. Memo.
1996-362 (note with term of 85 days); Estate of Graegin v.
Commissioner, T.C. Memo. 1988-477 (loan with balloon payment in
15 years, which was the life expectancy of decedent’s surviving
spouse, the beneficiary of a trust the assets of which could be
used to repay part of the loan); see also Estate of Sturgis v.
Commissioner, T.C. Memo. 1987-415 (term of loan not stated in the
opinion; it was at least 3 years).
Under New York law, interest incurred on a loan may be
deductible as an administration expense if it is necessary and
the estate lacks sufficient liquid assets. See, e.g., N.Y. Est.
Powers & Trusts Law, sec. 11-1.1(b)(22) (McKinney 2003).
The estate bears the burden of proof on all issues in
dispute in this case.10 See Rule 142(a)(1).
10
We treat the estate’s failure to respond in answering
brief to respondent’s argument in opening brief as the estate’s
concession as to burden of proof. We agree with respondent’s
contentions that (1) respondent raised no new matter in its
answer; (2) the litigation guideline memo (Mar. 14, 1989) cited
by respondent does not shift the burden of proof, see sec.
6110(k)(3); (3) Rauenhorst v. Commissioner, 119 T.C. 157 (2002),
relating to the effect of a revenue ruling, is distinguishable;
(continued...)
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As discussed next, we hold that (a) it was not necessary for
the estate to borrow funds to pay Bergreen or Davis because their
compensation was an expense of HG and was not an administration
expense of the estate, (b) it was not necessary for the estate to
borrow funds to pay administration expenses of $816,175, (c) it
was necessary for the estate to borrow funds to pay Federal and
state estate taxes, and (d) it was not necessary for the estate
to borrow funds for a term extending beyond January 31, 2004,
which is the date the estate was due to receive repayment of the
$143 million in notes.
2. Whether Compensation Paid to Bergreen and Davis Is an
Estate Expense
a. The Relationship Between the Estate and HG
The estate contends that expenses incurred relating to the
GIC assets after the estate transferred those assets to HG and
its subsidiaries in the restructuring are estate expenses. The
estate points out that, after the restructuring, (i) it continued
to exist and Bergreen and Moody retained the same control over
the sale of the GIC assets as they had before the restructuring;
(ii) the Gilman assets were not transferred to the foundation;
and (iii) the HG agreement gave exclusive management and control
over the Gilman assets to Bergreen and Moody, who were also the
executors of the estate. The estate contends that, by virtue of
10
(...continued)
and (4) the estate does not contend that sec. 7491 applies.
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Bergreen’s and Moody’s power over HG, expenses relating to the
Gilman assets were estate expenses. The estate also contends
that Bergreen and Moody acted primarily as executors in
facilitating HG’s sale of Gilman assets, and that they did so to
benefit the estate. We disagree.
Bergreen and Moody wore many hats: they were executors of
the estate, managers of HG, and members of the board of directors
of the foundation. As part of the restructuring, the estate
transferred GIC assets to HG and its subsidiaries. As a result,
the GIC assets, including the Gilman businesses, ceased to be
estate assets, and Bergreen’s and Moody’s management services
related to those assets were performed for HG and its
subsidiaries. The transfer of assets from the estate to HG and
its subsidiaries severed the relationship the executors had with
the transferred assets in their capacity as executors. Insofar
as Bergreen and Moody had the same duties and responsibilities as
managers of HG with respect to those assets as they had as
executors, it does not follow that their actions for HG were
taken in their capacity as executors. The estate claims both the
tax benefits resulting from transferring the Gilman assets to HG
and its subsidiaries (estimated by its tax advisers to be a tax
savings of $160 million), and all of the deductions that would
have been available to the estate if it had not transferred those
assets. Using executors to run a commercial enterprise does not
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convert expenses of the enterprise to estate expenses. The
estate cannot have it both ways. See Sharvy v. Commissioner, 67
T.C. 630, 641-642 (1977), affd. 566 F.2d 1118 (9th Cir. 1977);
L & L Marine Serv., Inc. v. Commissioner, T.C. Memo. 1987-428;
Biggs v. Commissioner, T.C. Memo. 1968-240, affd. 440 F.2d 1 (6th
Cir. 1971). Expenses related to the GIC assets were not estate
expenses after the estate transferred those assets to HG. See
Deputy v. Du Pont, 308 U.S. 488, 493-494 (1940) (taxpayer may
deduct own expense and not that of another); Estate of Grant v.
Commissioner, 294 F.3d at 354 (Court of Appeals denied deduction
under section 2053 of administration expenses incurred to
administer assets of a trust but allowed deduction of
administration expenses incurred to administer assets of the
estate).
b. Whether Bergreen’s Compensation Was an Obligation
of the Estate
The estate contends that $17 million of the Farm Credit loan
was borrowed to compensate Bergreen for services performed for
the estate. The estate also contends that amount was an
administration expense of the estate and was owed to Bergreen
under the will. We disagree.
Article 10 provides that Bergreen is not to receive
commissions or other fees for acting as executor and that he was
to continue to be compensated by the Gilman businesses for
services rendered after decedent died as he had been before
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decedent died. Bergreen was not entitled to compensation by the
estate under article 10.
Article 12 provides that, if the executors sell Gilman Paper
Co. while Bergreen is an executor, Bernard D. Bergreen, P.C., is
to be compensated for services rendered in connection with that
sale. The estate contends that Bergreen is entitled to be paid
by the estate under article 12 because the executors agreed to
act as managers of the assets of HG and its subsidiaries to allow
the executors to maintain control over the Gilman assets. The
estate also contends that HG and its subsidiaries were created to
effect the executors’ sale of the Gilman assets, and that
Bergreen retained complete control over the sale of those assets
after their transfer to HG and its subsidiaries. We disagree.
As a result of the transfer of assets from the estate to HG
and its subsidiaries, the estate no longer owned the Gilman
assets; HG and its subsidiaries did. Because the sale occurred
after the restructuring, Gilman Paper Co. was sold by HG (not the
estate). Bergreen and Moody rendered services in connection with
its sale in their capacity as managers of HG, not as executors of
the estate. Thus, Bergreen was performing services for HG, not
the estate. Bergreen was not entitled to compensation by the
estate under article 12.
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We conclude that Bergreen is not entitled to compensation by
the estate. Thus, it was not necessary for the estate to borrow
funds to compensate him.
c. Whether Davis’s Compensation Was an Obligation of
the Estate
The estate contends that Davis’s $5 million compensation is
an administration expense because Bergreen and Moody, acting in
their capacity as executors, hired Davis to manage Gilman Paper
Co. and to help Bergreen sell the Gilman assets, and that his
work for the GIC businesses benefited the estate. We disagree.
Bergreen and Moody were officers of GIC (as well as
executors of the estate) when they hired Davis to help revive the
Gilman businesses. Davis was rehired to serve as chief operating
officer of Gilman Paper Co. and Gilman Building Products in June
1998. The foundation’s compensation committee approved
Bergreen’s and Moody’s request to pay Davis $5 million for his
return from retirement and his turnaround and sale of the Gilman
Paper Co. Davis was paid $1.5 million in 1998, and $1.2 million
in 1999 and 2000. It appears from the foundation compensation
committee report that those payments were not part of the $5
million that Bergreen and Moody offered him and that the
compensation committee in October 2001 recommended that he be
paid. The accounting prepared by the estate as of February 28,
2003, does not show that the estate made those payments. It
appears that Bergreen and Moody hired Davis in their capacity as
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officers of GIC, and that the Gilman businesses (not the estate)
paid Davis those amounts.
The estate contends (and Bergreen and Moody testified) that
Davis was rehired to help to sell the Gilman businesses. We
disagree. First, Isabella Rossellini (Rossellini), an
independent director of the foundation, testified, and the Pearl
Meyer report states, that Davis was hired to run the businesses.
The Pearl Meyer report states in pertinent part: “Since June
1998, Mr. Davis has devoted his full professional energies and
time to Gilman business matters.” A document that Bergreen
prepared to justify his compensation to the foundation’s
compensation committee states that he hired Davis to fix the
companies. Neither the Pearl Meyer report nor Bergreen’s
document indicates that Davis was hired to help sell the Gilman
businesses. We conclude that Davis performed services for the
Gilman businesses and not for the estate. Thus, it was not
necessary for the estate to borrow funds to compensate him.
3. Miscellaneous Expenses of $816,175
The estate contends that the executors reasonably estimated
the amount it needed to borrow to close the estate, and that,
after calculating the tax savings resulting from deduction of the
interest on the $38 million loan, the estate estimated that its
tax savings would be enough to fund Bergreen’s and Davis’s
compensation, leaving $816,175 to pay other miscellaneous
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administration expenses. The estate contends that a reasonable
estimate satisfies the requirement of section 2053 that expenses
be necessary for the administration of the estate because (a)
only an estimate of the amount of the loan was possible when the
estate obtained the loan, and (b) the estate’s obligation to pay
the $38 million loan and interest thereon is fixed. Thus, the
estate contends, it may deduct the interest on that portion of
the loan to be used to pay miscellaneous expenses of $816,175.
We disagree because the record does not show what expenses are
included in the $816,175 amount. Thus, these expenses may no
more be estate expenses than was the compensation for Bergreen
and Davis. See paragraph A-2, above.
4. Whether the Estate Was Illiquid When It Borrowed Funds
From Farm Credit
Respondent contends that, after the estate paid the cash
bequests in May 1998, it had enough liquid assets with which to
pay its estate taxes and administration expenses and thus did not
need the Farm Credit loan. We disagree.
After payment of the cash bequests and before the
restructuring, the estate had more than enough assets to pay
administration expenses and Federal and State estate taxes.
However, these assets were illiquid. Every witness, including
respondent’s witnesses Rossellini, Justin Feldman, and John J.
Kennedy (all of whom were independent directors on the board of
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the foundation), testified that the estate borrowed funds because
it and the Gilman businesses were illiquid.
Respondent contends that the executors’ decision to transfer
most of the estate’s assets to HG and its subsidiaries on January
14, 1999, caused the estate’s illiquidity. We disagree. The
executors’ decision to restructure did not cause the estate’s
illiquidity; the estate was illiquid both before and after the
executors transferred estate assets to HG and its subsidiaries.
5. Whether the Estate May Deduct Interest on a Loan That
Could Have Been Avoided If the Estate Had Sold Illiquid
Assets To Pay Its Taxes and Expenses
Respondent contends that the interest on the Farm Credit
loan was not incurred out of necessity within the meaning of
section 20.2053-3(a), Estate Tax Regs., because the executors
could have avoided borrowing the funds by selling enough assets
to pay the estate taxes and administration expenses. We
disagree.
The executors acted reasonably in transferring property to
HG and its subsidiaries on the basis of advice they had received
that the restructuring would save the estate $160 million in tax.
See Beard v. Commissioner, 4 T.C. 756, 758 (1945); Hobby v.
Commissioner, 2 T.C. 980, 985 (1943); Tully Trust v.
Commissioner, 1 T.C. 611, 620 (1943) (taxpayer’s bona fide sales
to third persons for sole purpose of reducing his or her tax
liability was for legitimate business purpose; taxpayer was
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entitled to tax benefit resulting from sale of capital asset);
McKee v. Commissioner, 35 B.T.A. 239, 242 (1937) (trustees who
realized tax savings by selling, rather than redeeming, matured
bonds acted in the best interests of the trusts). We do not
substitute our judgment for decisions of the executors to
complete the restructuring in January 1999. See Estate of Todd
v. Commissioner, 57 T.C. 288 (1971); Estate of Thompson v.
Commissioner, T.C. Memo. 1998-325; McKee v. Commissioner, T.C.
Memo. 1996-362; Estate of Sturgis v. Commissioner, T.C. Memo.
1987-415.
Second, the executors did not foresee the decrease in Gilman
Building Products’ annual net positive cashflow from more than
$40 million per year in years before 2000 to $3.5 million in
2000. The decline in Gilman Building Products’ financial
condition contributed to HG’s inability to pay the estate nearly
$23 million of interest due in 2002. In light of the unforeseen
decline in Gilman Building Products’ financial condition and HG’s
and its subsidiaries’ inability to fully pay interest due on the
notes in 2002, it was necessary for the estate to borrow funds in
2002.
6. Whether the Farm Credit Loan Was Unnecessary Because
the Executors Had Elected To Pay Estate Tax in 10
Annual Installments
The executors elected on April 1, 1999, to pay Federal and
New York estate taxes in 10 annual installments beginning in
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2003. Respondent contends that the Farm Credit loan was
unnecessary because the estate could have paid the annual
installments of estate taxes from the proceeds of the sale of
estate assets or from the interest or principal on the $143
million in notes, due on January 31, 2004, without borrowing
funds from Farm Credit.
We disagree. After the executors elected to pay the estate
tax in 10 annual installments, respondent’s examiner told the
estate’s counsel that the estate’s transfer of corporate assets
to HG and its subsidiaries threatened the estate’s ability to
continue to defer payment of estate tax under section 6166, thus
making acceleration of estate tax under section 6166(g) likely.
Subsequently, on the advice of estate tax counsel, the executors
decided to pay the estate tax in full. Thus, we disregard the
fact that the estate had elected to pay the estate tax in 10
annual installments in deciding whether the Farm Credit loan was
necessary.
7. Whether, Under New York Law, the Executors Were
Required To Have the Foundation Return Assets to the
Estate To Pay Estate Tax
Respondent contends that the loan was unnecessary because
the executors were required, under New York law, to demand that
the foundation return to the estate the amount of assets needed
to pay estate taxes and administration expenses.
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We disagree. Under New York law, if an estate is insolvent
and the executor has distributed property from the residue that
the testator designated was to be used to pay estate expenses, a
residuary beneficiary must return that property to the estate to
pay the estate’s expenses. In re Estate of Schmuckler, 296
N.Y.S.2d 202, 207 (Sur. Ct. 1968); Buffalo Loan, Trust & Safe-
Deposit Co. v. Leonard, 41 N.Y.S. 294, 299 (N.Y. App. Div. 1896).
Under New York law, an estate is insolvent where its liabilities
exceed its assets. In re Estate of Froehlich, 416 N.Y.S.2d 744,
745 (Sur. Ct. 1979); In re Estate of Jacob, 401 N.Y.S.2d 986
(Sur. Ct. 1978). An estate may be illiquid but not insolvent.
In re Estate of Froehlich, supra at 746. Here, as the estate
points out, although it was illiquid, it was not insolvent
because it owned $143 million in notes after the restructuring.
Thus, under New York law, the executors were not required to
demand the return of assets from the foundation, and the
foundation was not required to return assets to the estate. See,
e.g., In re Estate of Schmuckler, supra; Buffalo Loan, Trust &
Safe-Deposit Co. v. Leonard, supra.11
11
Respondent contends that Bergreen and Moody had conflicts
of interest among their roles as executors of the estate,
managers of HG, and members and directors of the foundation, and
that the conflicts caused them to fail to demand the return of
the estate assets. In light of the fact that the executors were
not required to demand the return of assets from the foundation,
we need not consider respondent’s conflicts of interest argument.
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8. Whether the Estate Established Its Illiquidity After
January 2004
As part of the restructuring, the estate received $143
million in notes (subordinated to the $250 million line of
credit) from subsidiaries of Gilman Building Products and from
Gilman Paper Co.’s railroad. All of the notes were due January
31, 2004, after the record closed in this case. The $38 million
Farm Credit loan was made in October 2002, with repayment to be
completed in 10 years.
The estate contends that it was financially protected by the
notes. The estate does not contend, and the record does not
show, that the obligors would refuse to make arrangements to
fulfill their obligation to repay the $143 million in notes in
2004, or that the estate lacked legal recourse if HG refused to
do so. Respondent argued in the opening brief that the estate
could have paid its taxes and expense from repayment of the $143
million in notes. The estate did not respond to this argument.
We cannot conclude on this record that the estate needed to
borrow funds past January 31, 2004. Thus, we conclude that
interest accruing after that date on the Farm Credit loan is not
deductible.
9. Conclusion
We accept as reasonable the decision of the executors to
implement the restructuring and to borrow funds for a short
period to pay estate taxes. However, we also conclude that the
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loan was not necessary to the extent that funds were borrowed
beyond January 2004, or were to be used to pay unidentified
miscellaneous administration expenses or Bergreen’s and Davis’s
compensation. Thus, the estate may deduct a portion of the
interest and closing costs that accrued from October 18, 2002, to
January 31, 2004; the deductible portion of the interest and
costs is allocable to the portion of the loan used to pay the
estate’s Federal and State estate taxes.
B. Whether the Estate May Deduct $3,507,723 in Additional
Administration Expenses
1. Contentions of the Parties and Background
The executors paid administration expenses of: (a) $244,074
in legal fees to Cullen & Dykman; (b) $1,556,164 in consulting
fees to Price Waterhouse; (c) $633,347 in legal fees to
Fensterstock & Partners; (d) $826,364 in consulting fees to Pearl
Meyer; and (e) $1,247,775 in legal fees to Carter Ledyard,
counsel for the estate, for a total of $4,507,723. The executors
allocated those expenses to income. Respondent does not dispute
that these amounts were paid to lawyers, accountants, and Pearl
Meyer, or that the estate had income of $2,844,738. Respondent
concedes that the estate may deduct legal expenses of $1 million
that the executors paid from income.
The estate contends that it may deduct additional expenses
of $3,507,723 (i.e., that much more than the $1 million
respondent concedes) because those expenses are administration
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expenses under section 2053 paid by or on behalf of the estate
and the estate had enough income with which to pay the additional
expenses.
2. Whether the Additional Expenses Were Paid on Behalf of
the Estate
Respondent contends that the additional expenses are not
administration expenses because they were not paid on behalf of
the estate. The estate points out that Bergreen testified that
the estate paid $4,507,723 to Cullen & Dykman, Price Waterhouse,
Fensterstock & Partners, Pearl Meyer, and Carter Ledyard for
necessary services provided to the estate. The estate contends
that the additional expenses were paid on its behalf. We agree
in part and disagree in part with both parties.
a. Payments to Pearl Meyer
Bergreen’s memorandum, Exhibit 48-R, states that the
foundation hired Pearl Meyer. The estate points out that it paid
Pearl Meyer and contends that respondent reads Bergreen’s
memorandum out of context. We disagree.
Bergreen’s memorandum is consistent with the objective facts
of this case, including: (1) The New York State attorney
general’s office asked the foundation, not the estate, to
evaluate reasonable compensation of nine foundation executives
including Bergreen and Moody; (2) the Pearl Meyer findings with
respect to Bergreen and Moody are based primarily on Bergreen’s
and Moody’s activities for the businesses and the foundation, not
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their duties as executors; (3) decedent’s will provided that the
executors were not to receive executor’s fees or commissions; and
(4) the payments to Pearl Meyer were made long after the
restructuring. We give more weight to these facts and to
Bergreen’s memorandum than to Bergreen’s testimony and the fact
that the estate paid Pearl Meyer.
We conclude that the $826,364 paid to Pearl Meyer was not an
administration expense under section 2053.
b. Payments to Price Waterhouse, Cullen & Dykman,
Fensterstock & Partners, and Carter Ledyard
It appears from the record that the estate paid substantial
administration expenses, including payments to Price Waterhouse,
Cullen & Dykman, Fensterstock & Partners, and Carter Ledyard. We
accept the estate’s claim that the payments to Price Waterhouse
and Carter Ledyard, totaling $2,803,939, are expenses of the
estate. However, the estate failed to show that the payments to
Cullen & Dykman and Fensterstock & Partners were administration
expenses under section 2053; i.e., for the benefit of the estate
and not for the benefit of the foundation. The estate offered no
evidence other than Bergreen’s testimony on this point. We give
less weight to that testimony because of his less-than-convincing
testimony regarding the Pearl Meyer expenses. Because we believe
that the estate incurred substantial expenses for necessary
services provided to the estate, we allow the estate to allocate
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expenses of $1,803,939 to income in addition to the $1 million
that respondent has conceded.12
3. Conclusion
We conclude that the estate may deduct additional
administration expenses of $1,803,939 paid from income.
To reflect concessions and the foregoing,
Decision will be
entered under Rule 155.
12
We need not decide whether the estate had enough income
to pay all of its deductible administration expenses from income
because the amount we allow and the amount respondent concedes is
less than the $2,844,738 of income respondent concedes the estate
received.